Nicholas Grove: 2011 is a year many investors would probably rather forget, but what can they expect from the equities market in 2012. Here to help us prepare, I'm joined on the line by Morningstar Head of Equity Strategy, Ross Bird. Ross, thanks very much for joining us.

Ross Bird: Good morning, Nick. How are you?

Grove: I'm well, thanks Ross. First of all, what are going to be the most important influences, both positive and negative and external and internal, on our share market in 2012?

Bird: Yes, look I think 2012 is going to be another interesting year. In many ways, just a continuation on from 2011. I think some of the major themes that we had to grapple with this year are going to continue on next year and remain as the major themes. Let's go through the list. First of all, we start with sort of China and India, which are both important trading nations for Australia.

Their GDP growth has been quite strong of late. We expect GDP growth in both countries to slow somewhat a little bit next year. Not to say thatï¿½s doom and gloom, it's more just the rate of growth, not be absolute; whether itï¿½s going to grow or not, and we still expect them to grow strongly, but just maybe sort of slowing a bit from current levels.

So, some slowing there, but in absolute terms still very robust growth numbers that will require ongoing higher volumes of raw materials and energy from countries such as Australia. So, overall good, but just some moderate slowing from what we have seen this year and any past years.

For Europe, unfortunately, I think it's going to continue to be very much the same as this year. It is going to continue to struggle through, and we would not be surprised to see Europe go back into recession, at least for part of next year. Very difficult to sort of say for how long with what's going on there, but overall very, very weak growth if any growth at all for next year. No magic wand in Europe. It's going to take some years for them to sort their issues out, so in the meantime, relatively weak growth, if indeed possibly negative for a while there.

In the U.S., again, some of the recent economic data has been a little bit more positive than we were counting on, so thatï¿½s the good news, but nevertheless we still expect to see a bit of a muddle through recovery in the U.S. next year, similar to this year. GDP growth currently at 1.5% year-on-year for the third quarter there, somewhere around sort of 1.5%, 2%, is sort of where we're looking for the U.S.

So, again, a very slow recovery in this cycle compared to previous cycles coming out of a downturn and the key there is sort of jobs growth and housing activity, which is just taking a very long time to recover.

I think moving on domestically to Australia; look, general economic activity overall is quite solid, but we are still very much in our two-speed economy as we have discussed previously. So look overall, Nick, in many cases, similar conditions to what we've seen in 2011. I think, the broad themes currently out there are going to continue. However, Australia is likely to perform quite well in a relative sense compared to many of its other OECD peers, which is good news domestically, but Iï¿½d say challenges remain overseas.

Grove: Ross, which sectors of the share market are you most bullish about?

Bird: Yes, look, it's an interesting topic given the framework we've just discussed from a very broad macroeconomic basis. Obviously, investors, not just here, but around the world are going to remain very cautious and very nervous about challenges ahead that we've just discussed. So, I think in that environment, we need to continue to look at those sectors that are sort of effectively, non-cyclical, very essentially related to either services or products that we need in our everyday lives, things that we can't do without so to speak, and businesses that are not too dependent on growth from overseas, particularly in overseas, western economies.

So, really, we are looking at those defensive industrial sectors, such as: consumer staples, healthcare, utilities, and some infrastructure companies; telecommunications looking good, and we're also ï¿½ from a medium-term perspective, while we sort of maintain a positive view on China and India in the medium term, notwithstanding a few little challenges just in the shorter-term, we continue to have a favorable view on energy and the resources component of the material sector, you know, the production of iron ore, coal, base metal, such lot. But, just noting that the short-term is going to be a little bit challenging as China and India, sort of, overcome their inflation challenges there, but from a medium term point of view still very positive on those segments.

I think the domestic banks, again are in very good shape, and fundamentally we maintain a positive view on the banks as well. Nick, however, as we have seen this year sometimes investors view global banks as global banks and banks tend to get tarnished with a very broad brush when something bad happens overseas. Not that it has anything directly to do with our banks, but it's just the way investors behave. So, probably banks are going to continue to trade on very attractive looking multiples, but in an operating sense they're going to perform ï¿½ continue to perform well. So, we do love them fundamentally, but we just have to be a little bit patient in terms of, sort of I think, seeing the full results, come through from the good work that those banks are doing.

Grove: On the flip side, Ross, which sectors of our share market are you most bearish about?

Bird: We continue to be sort of fairly cautious towards the more cyclical sectors, ones that are just reliant on strong economic growth to see businesses do well. So, we continue to be cautious on the consumer discretionary sector, where I discussed the retailing situation just prior. Just to say, I donï¿½t think the interest rate cuts we've seen from the RBA today is sufficient to really sort of kick start the consumer and getting them back into the store per se, overlaying that of course with the structural changes we're seeing in retailing with online sales and the strengths of the A$ making overseas purchases sort of cheaper and even sort of traveling overseas and people spending their money overseas rather than here.

I still think that those sort of influences are still going to be around to make life tough for the discretionary retailer. Also cyclical industrials, companies in the building materials trade, non-mining construction sort of areas, I mentioned the non-essential retailing sort of areas, manufacturing businesses with the strong A$, likely to continue to find the going tough in 2012.

Grove: Finally, Ross, what is the most important thing investors should bear in mind when heading into the New Year?

Bird: I think, we are in an environment where there are ongoing challenges ahead at very much a global level. We always sort of have to come back to the principles of sound portfolio management, and of course, that is always choosing high quality companies. At Morningstar we have what we call ï¿½moat ratingsï¿½, which try and reflect the qualities of companies, so we would certainly suggest that portfolios should have preponderance of moat-rated companies in their portfolios, which the moat ratings can be found on the Morningstar website of course.

Companies with strong track records through a range of economic scenarios, not just companies that could do well in good times; we need to be comforted by holding companies that can perform well in challenging times, because no doubt we are in the midst of that sort of situation at a very broad level.

Also, I just mentioned in the previous question focusing on those companies that offer essential services or products for our everyday life, so companies involved in the utilities industry, telecommunication industry, things that we can't live without basically. I think, there it's important that the companies in those sectors that are well run, I think will be well supported by investors.

We also, I think, just need to keep in mind that while we are expecting more ongoing, if you like, bad news out of Europe and from time-to-time maybe from the U.S., we just always have to keep in mind that equities as an investment class are for the medium to long-term, and we ï¿½ we donï¿½t want to get too caught up in headlines and get too nervy. Indeed these conditions often present the best of buying opportunities for the right sort of stock.

So, we always have to maintain those disciplines of sound portfolio management, maintain diversity through portfolios, maintaining a sense of where fundamental value is, and if the market gets too sort nervous or bearish on particular sectors or stocks that can represent good fundamental buying to the medium term.

I also think, again what's emerging from 2011 and will continue next year, is that the importance of dividend yield as part of the overall investment returns in the portfolio. So again, looking for companies that have strong, reliable, dependable dividends, I think with a good franking component ideally is very much the focus as well, and really just being prepared to take that medium-term approach to portfolio management.